Rate Cut, Time to Buy HK REITs?

REITs have faced significant challenges over the past two years as the Federal Reserve aggressively raised interest rates. This is largely because REITs are inherently leveraged, borrowing to acquire properties. With rising interest rates, financing costs increased, which reduced cash flow available for dividends. As dividend payouts declined, REIT share prices dropped to maintain a yield margin above risk-free rates.

To make matters worse, China and Hong Kong REITs faced additional pressure from a property crisis and a slowing economy, which weakened rental demand.

Now, with the property crisis stabilizing and anticipated rate cuts likely to ease the financing burden on REITs, is there an opportunity to invest in Hong Kong-listed REITs for potential capital gains?

There are currently just 11 REITs listed in Hong Kong, as it isn’t a popular market for REIT listings. Mainland China only introduced its first batch of REITs a few years ago, making it a nascent market. In contrast, Japan and Singapore have long been more popular destinations for REIT listings in Asia.

We are focusing on REITs rather than property developers because REITs don’t carry the risk of having to sell developed units; instead, they primarily own completed properties and lease them out for rental income. In this sense, REITs may be less exposed to the ongoing property crisis, although they are still vulnerable to economic slowdowns.

Below, we have compiled the 1-month stock performance of these REITs, along with their Distribution Per Unit (DPU) changes over the past five years:

Firstly, we want to examine how REIT prices are responding to the impending rate cuts and assess whether capital gains are materializing. To do this, we ranked the REITs based on their one-month performance.

However, it’s worth noting that riskier REITs may experience larger capital gains because their share prices are inherently more volatile. These REITs tend to plunge more during rate hikes and rebound more sharply afterward, but overall returns may still be deeply negative, even after accounting for dividends. For instance, the top three performers—China Merchants Commercial REIT, Regal REIT, and Champion REIT—delivered gains of 12% or more over the past month, yet their five-year returns are still down as much as 63%.

We also considered the change in Distribution Per Unit (DPU) over the past five years. It was a challenging period, with most REITs reporting lower DPUs due to the factors mentioned earlier. That said, a few REITs bucked the trend. Notably, Link REIT and Spring REIT managed to increase their DPUs, though only by 1% over the five-year period.

We believe that REITs demonstrating DPU resilience are indicative of strong fundamentals—these REITs likely own properties in prime locations and have management teams capable of raising rents while retaining tenants.

With this in mind, we took a closer look at Link REIT, Spring REIT and SF REIT, as the latter’s share price has also shown resilience: